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A Pipe Dream

The narrative’s starting to seem
Increasingly like a pipe dream
Now central banks fear
That during this year
Slow growth is the new global theme

There is a lot to cover this morning as we await the US GDP print, so let’s get right to it. The most recent data released around the world has seriously called into question last year’s synchronous global growth meme. As this becomes clearer to central banks around the world, and as the inflation data continues to disappoint, all those hawks at the ECB and the BOE are starting to sound increasingly feeble. Meanwhile, the US remains an island unto itself when considering growth, and perhaps more importantly, inflation.

Yesterday the ECB left policy on hold, as universally expected but during the press conference Signor Draghi said something I find very interesting. He told us that the committee didn’t even discuss monetary policy during their two-day meeting, rather that all the time was spent poring over the recent data and trying to determine if the obviously slowing growth in Q1 was an aberration or the beginning of a trend. And they arrived at no conclusion. With this in mind, the hawkish bona fides of the ECB took another step back. And this morning they were rewarded with weaker than expected French GDP data, as Q1 grew only 0.3% in the quarter and the inflation readings remained unchanged at 1.6%, rather than rising as expected. Eurozone data is released next week, but thus far, the larger countries, other than Germany, seem to be faltering slightly. Remember, we continue to see this from non-Eurozone countries like Sweden as well. The point is that the hawkish read on the ECB, ending QE cold turkey after September, is becoming less and less likely. As to the euro, it responded exactly as you would expect, falling 0.7% yesterday and a further 0.2% this morning, breaking below the bottom of the previous trading range and bringing 1.20 clearly into view.

Meanwhile, UK GDP data also disappointed greatly, rising only 0.1% in Q1, and the market has now virtually removed any probability for the BOE to raise rates next week. Remember, last Wednesday, before Governor Carney mentioned that there was more than one meeting at which they could act this year, the futures market had priced an 86% probability that the BOE would raise rates by 25bps next week. This morning that probability has fallen to around 20%, with the market now pricing only one hike in for the entire year, and that not until November. Here, too, the pound responded as you might expect, falling sharply this morning, -1.1%, which is more than 4% lower than its recent peak and back to the lowest level since March 1st. And Brexit wasn’t even part of the discussion, although that issue is not about to disappear. Once again I will say that there seems very little likelihood that the BOE can raise rates into the greatest economic uncertainty that the UK has experienced since the financial crisis.

Inflation remains
So difficult to create
If you’re Japanese

Which brings us to the Japanese, where the BOJ’s two-day meeting concluded last night and they left policy unchanged…almost. In fact, while they didn’t adjust their target on the 10-year JGB yield, which remains 0.0%, they scrapped the timeline for achieving their 2.0% inflation target. Ever since Kuroda-san was first named BOJ chief five years ago, he has been trying to talk up inflation in Japan by saying that the BOJ would drive inflation to their target within a two-year time frame. Now, they have had to revise that time frame six times already, and if you recall, earlier this year he even talked about how they would end stimulus when they reached their 2.0% target in two years’ time. Well, in a complete reversal, while they continue to target that inflation rate, they will no longer explicitly demonstrate their ineffectiveness by missing their target date. It will just remain a long-term goal, sort of like those last 5-10 pounds we all want to lose someday. While one economist had an interesting take, that this will allow them to start tightening policy even though they are not near their target, that doesn’t pass the smell test for me. Instead, it feels more like they have finally realized that jawboning inflation higher is not the same as jawboning the yen lower. In the end, the yen fell a bit further, extending its recent decline and now sits at its lowest level since early February.

On the other side of the dollar story, the most notable mover has been KRW, which appreciated a further 0.5% on the back of the apparent official cessation of hostilities between North and South Korea. This has enormous geopolitical ramifications, especially if it is followed up with an accord between the US and North Korea. After all, will the US continue to need a significant military presence in South Korea if peace comes and the denuclearization of the peninsula is achievable in a verifiable manner? And what would that mean for China? It seems there are a lot of potential questions to come from this yet, however, it certainly seems like it is a positive result. It seems to me that KRW has the opportunity to appreciate further on the back of the news if it continues in this direction, regardless of the overall dollar situation.

With a full twenty-four hours of activity behind us, it is time to look ahead to this morning’s US data. The big number this morning is Q1 GDP (exp 2.0%), with the component Price Index (2.4%) and Real Consumer Spending (1.1%) released simultaneously. We also see the Employment Cost Index (0.7% Q/Q) which given the Fed’s focus on wage growth may take on heightened importance, especially if it prints higher than expected. One of the things that we have seen consistently from the survey data, as well as the Fed’s own Beige Book, is that companies continue to have difficulty filling jobs and have begun to increase wages in order to attract new workers. Those anecdotes can be confirmed by this data, and if they are, look for an even more hawkish tilt to the Fed next week. In fact, while I think it is a low probability, it is not inconceivable that the Fed alters policy in some manner next week, despite the lack of a scheduled press conference. After all, they can always schedule one late, and I’m confident nobody would miss it. I’m not saying this is likely, just that Chairman Powell is clearly cut from a different mold than the three previous Fed Chairs, and so could well shake things up.

At any rate, the story that has unfolded over the past several weeks is the one that I have been discussing for the past several months. US growth and, especially, inflation have been pushing higher while those indicators elsewhere in the world are ebbing. The result is more hawkishness here and less abroad, and as I have consistently reminded you, the likely outcome is for the dollar to continue to benefit. I see no reason to change that view barring a decidedly worse than expected data print this morning.